China

This is important. According to a story in the New York Times today, the Chinese Army is back in the business of hacking into American computer systems to steal intellectual property and government security secrets. After a three month lull that coincided with a tongue lashing by the Obama administration the People’s Liberation Army (PLA) unit 61398 is back in business and already operating at 60 to 70 percent of its pre-stand down effectiveness.

The story discloses how Coca Cola lost a bid to acquire China Huiyuan Juice Group after its systems were hacked and the Chinese presumably got Coke’s strategy documents. The article also documents intrusions into defense suppliers and companies that have detailed information about American pipeline and electrical grid infrastructure.

It is clear that the Chinese aren’t going to stop this behavior with a polite request and the U.S. government has to take more direct action to make its displeasure known.

From a broader perspective, this isn’t how business partners are supposed to act. China has to figure out if it wants to have a productive relationship not only with America but with the West in general. For whatever reasons, the West and the Soviet Union chose confrontation, which resulted in a strategy of containment and by 1989 the Russians were barely functioning as an economy which resulted in the breakdown of the USSR.

If the Chinese want to go that route we should know and we should act accordingly. First step, Tweet this, pass it on and make some noise. We’ve lost a lot of factories to overseas competition but if we lose our IP we’re toast.

It was only a matter of time before slack demand in the rest of the world backed up into China, the world’s biggest manufacturer. According to an article in the New York Timesfinished goods have been piling up in Chinese warehouses, car dealers’ lots and in the spaces between other things in factories.

China is in the early phase of an inventory recession, a situation that happens when production gets ahead — or in this case, way ahead — of demand. It’s a textbook case of too many goods chasing too few dollars, Euros, Pounds — you get the idea.

We see much less of this kind of downturn in the west for some good reasons. First, we have really good supply chain technologies and practices so we know early on that things will back up and manufacturers slow down production to avoid having the kind of glut that now affects the Chinese. Second, and more important, we take the signals from the market seriously and have transparency in government. We report the actual truth instead of what we think we want to see. The Chinese? Not so much, especially in the latter case.

Classically, the remedy in this situation is to curtail production, which leads to fire sale pricing. Economists call this working off the excess inventory, real people call it unemployment. The Chinese government can’t afford unemployment especially now because they are in a once in a decade leadership swap-out and because employment is the national unemployment plan.

See? No?

They don’t have much of a social safety net and the government doesn’t want to throw a number of people out of work that might rival the entire population of a European country or large American state. So the finished goods pile up.

Short term, WalMart has more to sell at lower prices. But soon the reverse will have to happen. Goods will get scarce and prices might actually rise. Maybe.

The recession mania around the world is unfolding like a textbook demonstration of all possible types. Here in the west for instance, we are having — or had depending on where you live and your political persuasion — a credit based recession. That’s where there are too few dollars chasing goods and services but not leading to inflation because demand has dug a hole in the floor.

It’s not like there is no actual demand, but for some reason, banks have had to rebuild their balance sheets after the wild party they threw themselves five or so years ago and they aren’t lending. So in this case, lack of credit is stifling demand.

Whatever happened to supply side economics? You know, the idea that if you build it they will come? The Chinese have done their jobs in the supply side scheme but the rest of us seem to be letting them down.

Actually, the part of supply side no one likes to talk about goes like this: all markets clear — at a price. This means that products match up with buyers until all the product is all gone, but there’s no guarantee what the price will be for the marginal goods, i.e. those that were made in excess of reasonable demand. That’s where the firesale comes in.

Oh sure, things are beginning to get better in selected places but in most cases the economy is still pushing on a string. What to do? Too many goods in the Far East, too little credit in the rest of the buying world and suddenly, too little employment all over the place. The prevailing wisdom tells us to tighten our belts and show confidence but we’ve been doing that for many years already and the “Confidence Fairy” as Paul Krugman would say, has failed to materialize to sprinkle pixie dust on the economy.

If you could apply Fitzgerald’s definition of a first-rate intelligence to a thing or group endeavor—always a dubious proposition—Exhibit A might be the New York Times. This week the Grey Lady published two contrasting pieces that demonstrate the conflicted nature of our economics and the ways we think about globalization.

First up is Thomas Friedman’s opinion piece about Apple and its manufacturing prowess, through Foxconn, in China. Friedman makes the point in “Average Is Over” that manufacturing has increasingly moved to China over the last decade because China is so attuned to the demands of global manufacturing that it can easily outcompete American companies with its flexibility to changing global circumstances.

Friedman’s example is instructive. In his piece he references how a factory in China was able to move from a standing start to manufacturing ten units per day of revised versions of the iPhone (with Corning Gorilla Glass replacing plastic for a harder and more scratch resistant surface) in a matter of hours. Friedman tells the story of how 8,000 workers were roused from their beds in company dormitories, given a biscuit and a cup of tea and sent to work in the middle of the night to accommodate Apple’s revised demand.

Friedman extols the Chinese for their work ethic and ability to provide the manufacturing flexibility that modern markets demand. But a second article in the Times “In China, Human Costs Are Built Into an iPad” discusses in fine detail the cost of that flexibility. In the article we see what it really means to be dragged from bed and fed that heroic biscuit. It documents 60 hour work weeks, forced overtime and working environments that are, some cases literally lethal.

The article documents how poor ventilation led to fires and explosions in manufacturing facilities and death to some workers. It documents suicides too as workers jumped from their tall dormitory windows unable to cope with the demands of high production for $22 per day.

I think Friedman confused capitalism for what the Chinese practice aided and abetted by their government and by American business. Friedman envisions a plantation economy, not modern business. It is a form of mercantilism, not capitalism. It exploits workers and other resources in countries where the labor and safety laws are lax and environmental standards practically non-existent.

Take a look at this list of mercantilist characteristics from Wikipedia. How many do you recognize?

Mercantilism requires two actors, the colony as well as the colonists, thus you have networks of colonies owned by the colonists and restricted domestic consumption in the colonies and this perfectly describes the relationship between Apple and other manufacturers and their Chinese partners.

Ironically while the business interests advocate a neo-mercantilism the U.S. government has had little success at getting the Chinese to open their markets to more capitalism, more foreign goods and to let their currency appreciate to more realistic levels. This might look like a disagreement between countries but it is actually an argument between American business and the federal government.

This relationship disenfranchises both the workers in one country and the citizen-consumers on the other. And this doesn’t even touch the issue of lost jobs moved overseas by the mercantilists chasing low labor costs and the ability to ignore health and safety laws.

A form of state sponsored desperation-growth drives Chinese mercantilism and a generation of its people ignore what’s happening in its factories in a vain effort to catapult the country from poverty to emergence and ultimately to first world status.

Friedman holds this up as some kind of aspirational goal for Americans. He seems to be saying that if only we could be a little more like the Chinese we could recapture our manufacturing base. But this amounts to prostituting ourselves, our country and its resources to a gratuitous mercantilist ideal.

Why not go in the other direction? The opposite of mercantilism is not suspension of trade but trade on a more level playing field, one where profits are not made through arbitraging safety and dignity. Real capitalism.

Companies like Apple have the upper hand. The conditions in their factories are sanctioned either explicitly or implicitly by them and will only persist as long as Apple applies benign neglect to the situation. Alone Apple determines what it will pay for components and labor so that it can meet price points in the Fast New World economy.

Other computer and consumer electronics makers use some of the same Chinese manufacturing partners to make their products. We like those products a lot and we especially like their low prices. But hidden behind those shiny new things and their low prices are 16 hour work days, no time off, regressive discipline and dangerous working conditions.

I like my consumer electronics but not with the hidden costs that are attached to every device. Those costs include an eroded and impoverished first world manufacturing base and despotic working conditions where those jobs end up.

In 1906 Upton Sinclair published The Jungle, a book about the lives of American immigrants. The book spent many of its pages portraying life in the corrupt meatpacking industry. From that book we derived the sage idea of liking the sausage but of studiously avoiding asking how the sausage was made.

In effect, we’ve been told not to try to hold Fitzgerald’s twin opposing ideas in mind. But the Times was able to do just that and to offer us a compelling and discomforting contrast. The larger question is whether or not any of us retain the ability to, as Fitzgerald suggests, function in the face of this information.

Who would have thought that a software company would become a pivot point in the east-west struggle to define globalization and capitalism in the twenty-first century? The obvious software companies that have direct effects on globalization — companies like Microsoft, SAP, Oracle and Salesforce.com all have important application level solutions that contribute to the global ball of wax but they were not involved. None of them has had the effect that Google has had in the last week.

The search company came to the situation quite by accident, without intent and to be honest, I think they were unwilling participants having been pushed or more likely pulled, into the mess. Of course I am talking about Google’s ongoing dust up with the Chinese government.

Earlier this week we got word of an attack on Gmail servers by computers in China in which the Chinese tried to obtain data about the private email accounts of Chinese dissidents. In addition to the Gmail attack, 33 other companies were hit. In those cases valuable computer source code was stolen or at least an attempt was made to steal it. It was not the first time something like this happened. If you check out another piece on this site you can find more details.

As a Chinese proverb says, “May you live in interesting times.” Well this is it. And keep in mind that the translation of interesting is anything but benign. The implication in interesting is turbulence. The incident, and Google’s reaction to it come at a very interesting time. China has established itself as the world’s workshop with a ten percent growth rate and all of the problems that go with it including high expectations of an improving standard of living.

Much in contrast to what many talking heads have spouted, China has not discovered capitalism so much as it has harnessed mercantilism, an economic system that focuses making things for export while depressing the value of its currency and repressing its people.

China has used the trappings of capitalism — especially importing foreign capital and expertise to rapidly evolve from a poor agrarian economy to one that is increasingly urban and oriented toward building cities, power plants, roads and more. In short, the country is modernizing at breakneck speed. We know all this. (Did I already mention the ten percent annual growth?)

Keeping the lid on mercantilism requires authoritarian rule and control of information to better control the populace. Orwell had it right. But for a country growing as China is, the stirrings of the people for a better life goes well beyond the material. The American social scientist, Abraham Maslow showed in a famous paper published in the 1940’s that humans have a hierarchy of needs, the higher ones focusing on self actualization and self esteem.

The problem for China is that controlling information as it does will have little effect on its manufacturing prowess. But the game has changed, recent global events, most notably the credit crisis, are drying up markets. Western consumers have mortgaged themselves silly trying to buy all of the semi-useful plastic that China, Inc. spews out like so many salad shooters. China’s inevitable evolution as a nation has to be in areas that are information intensive and there’s the rub. In a nation where the state controls information flow, the essential raw material of China’s future will be forever bottled up causing an impediment to future growth.

Moreover the world’s attention is focused like the proverbial (Ok, Clintonian) laser beam on what China does next. The world economy that has invested in China and bought its goods still has not gone “all in” and how the Google affair is handled (and the obvious larceny of intellectual property) will have a lot to do with China’s future.

So far, the world community has been very reluctant to say much beyond President Obama’s comments yesterday endorsing Google’s stand. If it was up to me, I would tell the Chinese to turn back one containership full of merchandise for every company that was hacked. Please don’t tell me about all the Americans who would be hurt by this shortfall of merchandise. Sometimes you have to take a stand.

It took the world ten long years to forget Tiananmen Square and when China was finally allowed to join the World Trade Organization in 1999 it was with the understanding that China’s leaders had learned something and grown. The events of the last week stand in stark contrast. China seems to be taking on capitalism and globalization as if they were at a buffet. This isn’t a buffet — democracy and basic human freedoms as expressed by the U.N. Universal Declaration of Human Rights are all part of the package. If you want to be in the game, that is.

Google grew a pair today and told China to quit messing around in its business or Google would cease operations in the People’s Republic. The incident that provoked the tension involved a massive hack last week from computers operating in China. A total of 34 companies including Google were hit and most of the larceny involved source code. But in Google’s case, the larceny was of the company’s soul and reputation for trustworthiness.

Chinese hackers had attempted to discover the gmail addresses of dissidents inside China. It is not clear from the report in the New York Times that the hack was successful but this was not the first time something like this happened either.

“In its public statement Google pointed to a United States government report prepared by the United States-China Economic and Security Review Commission in October and an investigation by Canadian researchers that revealed a vast electronic spying operation last March.

“The Canadian researchers discovered that digital documents had been stolen via the Internet from hundreds of government and private organizations around the world from computer systems based in China.

The five-year relationship between Google and China has been a rocky one from day one when Chinese officials demanded that some Google searches like “Tiananmen Square massacre” turn up no information. And as recently as June Chinese authorities blocked Google temporarily over another issue.

The existence of cyber warfare or cyber espionage has been known for some time and the United States does its share. Some people say Google’s actions are overblown and that the company cannot afford to walk away from a market that has 300 million search users (and growing) and generates $300 million per year for Google, but I strongly disagree.

The logic of not wanting to walk away from this lucrative emerging market has the same merit as boiling a frog and if you look at the relationship to date, the United States is having its lunch money taken by the Chinese. In the name of future profits we are sending jobs overseas and we are not receiving anything as valuable in kind.

According to The American Prospect magazine, since China joined the WTO (World Trade Organization) the main referee of globalization, 42,400 factories have left the United States for China. That’s not jobs, that’s factories. Ross Perot was right about that giant sucking sound, it’s jobs baby jobs.

So why do we continue to kowtow (a nice Chinese word) to an authoritarian regime that treats us this way? This isn’t globalization as it was envisioned, it’s mercantilism and it’s doing us no good to pretend otherwise. This nonsense has to stop.

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